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Thought for the day, 31 January

Gold is at a three-month low. Is this a buying opportunity or a reason for caution?

Gold has fallen in price of late. Browse the Internet and there is no shortage of articles trying to justify the drop.

CNNMoney quoted Daniel Brebner, precious metals analyst for Deutsche Bank as saying: “There’s a growing consensus that the US economy is back on solid footing and the Fed could begin reining in its ultra-accommodative monetary policy… If this is in fact the case then gold is no longer required as part of a portfolio.”

Well, on Friday Mr Brebner was given some evidence to back his claim. The US economy expanded by 3.2 per cent in Q4, from 2.6 per cent in the quarter before. Forget about looking beneath the surface for a few moments and just look at the headline figures: the US economy seems to be enjoying something of a rip-roaring success.

Then there’s news on China. With fears that the Chinese economy is overheating, and that to counteract this her central bank will slam on the brakes, there is growing talk that commodity prices will fall back later in the year. And that, argue some, will pull down on the price of gold.

But hold on a moment. Is that really right?

Are analysts not having their cake and eating it here? The US economy is booming, they say, and thus gold will fall. China is set to slow, they say, and thus gold will fall. In other words, the answer is gold will fall; now what’s the question?

Economists and analysts tend not to like gold. It pays out no yield, its strength seems to lie purely with psychology. The fans of gold argue that in the past it was the place of safe refuge, and therefore it will be the place of safe refuge in the future. It is just that particular argument does not sit well in textbooks on economic theory. No wonder Keynes called gold a ‘barbarous relic’.

So I can’t help but feel we are seeing prejudice here. Economists don’t like gold, so they are looking for reasons to justify its lower price.

But for me, the underlying factors that led to surging gold last year have not gone away.

A recent Bloomberg poll found that the majority of investors reckon either Greece, or Ireland, or maybe both, will default by 2015. The danger of a debt crisis in Spain and Portugal, and even Italy and Belgium, has not gone away. The same problems still lurk. I can’t help but feel market complacency shows a degree of gullibility.

Standard and Poor’s recently cut its credit rating for Japan, and Moody’s has warned that it may have to place a negative outlook on its AAA rating for the US. Stop there, and re-read that last sentence. Credit rating agencies are beginning to fret over even Uncle Sam’s ability to pay back debt.

The truth is the US economy is booming because the US government is spending money it doesn’t have. The argument used to justify the US government running up debts is that the US as a whole is not getting into more debt. The argument continues: households are paying off debts, and the US government is simply borrowing the money its households are saving. But surely, before the financial crisis dawned, household debt in the US was dangerously high. The US is swapping one kind of dangerously high debt for another – this is hardly sustainable.

I fail to follow the argument that gold has peaked. The factors that created the fears that led to surging gold have not gone away; if anything they are getting worse.

I am dubious about the price of gold in the longer term, however. I mentioned last year how there is strong evidence to suggest that later this decade real interest rates will rise, as global investment rises and global savings fall.

You can see why a product that pays no yield does well when real interest rates are negative. But if real interest rates start to rise, as I am sure they will within a few years, gold will look very expensive.

These views and comments are those of the author alone and do not necessarily reflect the view of The Share Centre, its officers and employees

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Tony Brooke commented on January 31st 2011, 06:08PM

"Reading avidly for a clue on whether to Buy or Sell, the many answers each seem to depend a lot on where you’re stood when looking at the problem. Traditions in Asia favours the long view on Gold. So people buy it whenever they can at any price, and wear it for the confidence or joss bling brings to things. Not unlike the Gold Standard in some ways, maybe?
"

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